SEC Eyes Potential Order Routing Disclosures

Requiring brokers to provide more transparency into their stock order routing practices would give investors more information on where their trades are being executed.

The U.S. Securities and Exchange Commission is said to be considering a plan to require brokers to disclose their order routing practices to the public, according to two separates reports in Bloomberg and Reuters.

When buying and selling stocks, institutional traders submit their orders to brokers which have a choice of 13 public stock exchanges and more than 40 alternative trading systems known as dark pools.

Critics have questioned the financial motivations of brokers since they may earn a rebate or pay a fee at certain exchanges depending on whether they add or take liquidity. Brokers also can choose to rest customer orders in their own dark pools initially, and if it fails to result in a trade, the order is then sent to other dark pools, which are private venues that charge a lower fee than exchanges. It’s been said that the remains or “exhaust” is sent to exchanges.

Order routing practices have received more scrutiny from regulators as a result of the book “Flash Boy’s” by Michael Lewis, which described how high frequency traders can ‘ping’ dark pools to learn of a large order, purchase the stock on an exchange, and then go back and sell the stock at a higher price to the institutional investor. Although institutional investors have known about these practices for several years, the book has sparked renewed focus on these allegations.

In the Bloomberg article, Andy Brooks, head of US equity trading at T. Rowe Price, said that requiring brokers to disclose “every step they took to fill a customer’s order” could help investors to protect against predatory behavior described in Lewis’ book.

Currently, investors are not aware of all the stops an order makes, unless they request this information from their brokers. This information is available through standardized electronic messages or “FIX Protocol tags” that transmit the electronic orders from one venue to another.

While large investors can demand such reporting, regulators could require “a very detailed and comprehensive template” that would allow investors to compare the brokers they use, he said.

“It’s where you went and didn’t get an execution that begs the question of why did you go there?” Brooks said in an interview. “Why is a broker sending an order to a venue where you get no execution?”

Mandating more disclosure is one way that the SEC could address the opaqueness and complexity surrounding order routing. But order routing isn’t the only area that the SEC is examining. According to Bloomberg, the SEC is said to be reviewing every aspect of how stocks are traded and regulators are trying to identify changes that could be implemented quickly.”

In the Bloomberg article, SEC Commissioner Kara Stein told Bloomberg that there’s a lot of “low hanging fruit,” that should be considered, suggesting that order routing is one such area that could easily be made more transparent.
However, disclosure of stock routing would not change the underlying financial incentives that motivate brokers to route to certain exchanges or dark pools. In the Bloomberg, article, Brooks said the SEC should experiment with altering the financial incentives (i.e., maker-taker ) that offer rebates to brokers to attract order flow.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio